On the McCain Health Care Plan

Joe Biden and she-who-must-not-be-named did debate recently on many issues. One of the issues that struck me was that of health care. It struck me so much, in fact, that my reactions to watching mentions of it on TV drew much attention at the bar at which I was viewing the debate. Any mention of the McCain health care plan made me want to vomit. I thought it would be a good idea to try to explain why.

First a bit of background. Healthcare in the US is pretty awful. An oft-quoted statistic in opposition to my claim is that the US spends more on healthcare than most other countries. When you consider that many Americans aren’t covered at all and most are only partially covered, this statistic is more indicative of inefficiency than anything else. Yet, as I have experienced, paying for health insurance here can be very costly, partly because the health care itself is very costly (although, admittedly, it is generally very good).

The concept that I will be invoking is known as “Rothschild-Stiglitz” equilibrium and it basically applies to situations of information asymmetry in insurance markets. Yes, this is the same “Stiglitz” as the one who hangs out at Columbia. In fact, this work eventually led to a Nobel Prize. The original paper on this is quite good and I would encourage the enthusiastic reader to peruse it. I will try to simplify the details and preserve the essence of what is being said while resorting to as little mathematics as possible.

For simplicity’s sake, let us take an imaginary population composed of two distinct groups of people – Red and Green. Red people are high-risk, prone to illness and such and green people are low-risk. It doesn’t really matter. If it helps, think of it as young male drivers vs older (but not senile) female drivers and substitute health insurance with car insurance – the concept is basically the same. So we have these two groups of people and they want to buy insurance. We will assume an insurance market with perfect competition (i.e. perfect information, zero profit, and no monopolies)

Now let’s say that insurers have some way of telling which people are Red and which are Green, like a test. Let’s also assume that Red and Green people know what colour they are. What will happen? This seems like a no-brainer, and that’s because it is: Red people will be charged more for insurance and Green people will be charged less. That is, their premiums (periodic payments) will be larger. The fixed deductible (the fixed amount that they MUST pay whenever they make a claim) will be relatively small but, importantly, it will be about the same for both Red and Green people.

As an interesting aside, making the test optional doesn’t actually make a difference to the end result. I will leave that as a simple exercise for the reader.

In real life, however, it is very difficult to tell the Red from Green. Maybe insurance companies are red-green colourblind, maybe there are anti-discrimination laws, perhaps testing technology isn’t up to it. If we present this population with the same choices as before, a very obvious thing will happen – everyone will buy the plans that were originally offered to the Green people, because it is cheaper. Since we have a market with perfect competition, the insurance companies will raise the premiums otherwise they will lose a lot of money to those pesky high-risk Red people. But is this the only thing that can happen? This is where it begins to get complicated.

There is another possibility. There can exist two types of plans – one with a very very high fixed deductible and low premium, and another with a much lower fixed deductible and a much higher premium. Can you guess which one is aimed at which group? The plans with a high deductible are aimed at the Greens, because in the end, their expected value (the probability of an outcome multiplied by the cost of that outcome) is the same, yet the high deductible would discourage Reds from buying those plans. The situation is essentially the same for Reds whose higher probability of having an accident favours the plans with a lower deductible even though it has a higher premium.

However, since we have a market with perfect competition, was can expect all of these possibilities to play out. In fact, when you put all of these supposedly stable equilibria in the same ball park, you get an interesting result – there is no stable equilibrium that gives full insurance to everyone. There is the trivial solution, where nobody is insured, and there are a handful of “special cases” which rely on specific ratios of Red to Green people.

What does this all mean though? Basically, my interpretation of it is that laissez-faire free market philosophy cannot work in insurance markets with asymmetric information. Nevermind the fact that coalition building and monopolies exist; even with perfect information and perfect competition it CANNOT work.

What does this mean for John McCain’s health plan? First he’s going to tax work-based health insurance more, which will basically kill it. He will deregulate the market… a bit iffy for very different reasons, but not entirely unreasonable on the surface. The real kicker is that he will give people a tax break in the form of money with which to go out and buy your own health insurance. The idea, or dogma rather, is that you’re giving consumers choice and creating a competitive market. This can only work at all if there is perfect information on both sides and there is not, nor can there ever be.

What would happen under the McCain plan? Well, health insurance is expensive. If you’re young and healthy and have just come out of College with a lot of debt, you’re going to want to save as much as you can, wherever you can. You might even risk not having health insurance, or not being fully-insured… what happens then? Well, older people, smokers, obese people, basically people who know that they need insurance will see their premiums go up, probably to the point where some can’t even afford it.

Basically, the McCain health care “plan” does what most of his policies and, indeed, most of his campaign seems to do – it divides America and leaves us worse off for it. Moreover, in keeping with Republican ideals, it favours the rich over the poor, which is ridiculous because very wealthy people are the ones who need health insurance the least.

For example, between me and my parents (my Dad’s a diabetic and they’re both quite old, mind) we could probably have afforded every single doctor’s appointment, prescription and operation that we’ve had done and not suffered greatly from it, but thanks to good foresight in ensuring that we have good health insurance (information that is generally more easily accessible to wealthy people, but that is a different issue), we’ve only paid a fraction of that cost. By contrast, poorer people cannot afford this and while Medicare in the US will pay for emergencies (because THAT’s a good healthcare strategy (I’m being sarcastic)) it will also charge an amount that would send most people bankrupt; which is exactly what happens a lot of the time.

The simple solution to all of this is to do what many other countries have done and nationalize it and charge everyone the same amount (taking it out of their taxes, basically). This also gives government incentive to promote preventative healthcare programs which improves everyone’s health (don’t forget that) and are also far more cost effective than waiting until emergencies to intervene. Currently, private insurers have no incentive to engage in promoting preventative strategies because they, in their competition with each other, will cut costs by under-insuring people. By making the market competitive, the equilibrium you end up with is (unsurprisingly) the competitive market equilibrium (read Gerard Debreu and Kenneth Arrow’s paper about this, it’s effing great). Sadly, the competitive equilibrium isn’t the optimal solution, at least as far as providing healthcare for everyone is concerned.

Many people argue for universal healthcare on the grounds of equity and appeals to standards of “fairness”, and there’s nothing wrong with that. However, at the end of the day, somewhat counter-intuitively, nationalizing healthcare actually (amazingly) makes it cheaper and the effect becomes more pronounced over time because the incentives are structured differently. Some may argue that the Green people get shafted in favour of the Reds, but if you think about it, first of all, there aren’t many Reds relative to Greens and, moreover, the spectrum is continuous. The average person begins life as a green and, as they age, become more and more Red. So, in the end, applying what is essentially the same plan to everyone makes a lot of sense.

It is a joke that the US doesn’t have universal health care, but John McCain’s health care plan is beyond a joke, it is an utter farce, and nothing good can possibly come of it. Barack Obama’s isn’t perfect either; it is far from it, but it is closer. (If he went as far as I do, he would probably lose support for being TOO liberal, or be accused of being a socialist/communist).

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"We dicovered something. Our one hope against total domination. A hope that with courage, insight, and solidarity we could use to resist. A strange property of the physical universe that we live in. The universe believes in encryption. It is easier to encrypt information than it is to decrypt it."